maximising profits[1].ppt

8/14/2019 Maximising Profits[1].ppt

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MAXIMISING PROFITS

We have seen how the cost curves of a firm were used to derive the

supply curve. (Supply = MC > AVC)

Firms operate under conditions influenced by diminishing returnsin the short run

MC =S

Quantity

Costs($)


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This graph shows two ways ofhow profit maximisation level ofoutput for the firm can beestablished.

First- using total revenue andtotal cost:

Shows the firm maximising totalprofits where TR-TC ismaximised.

Second: Firm is maximisingprofits where MR=MC.

For any output < Qe such as Q1

MR>MC the firm shouldincrease output as it will makelarger profits as long asMR>MC. (the extra revenuegained from selling the last unitof output > extra cost incurred in

producing it.


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Profit max where MR=MC

Producing an extra unit of outputbeyond Qe (such as Q2) will result inthat unit of output adding more tototal cost than it adds to total

revenue MR


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MAXIMISING PROFITS EXAMPLE

Look at Q=2

What is the associated MR?

MR=$10

What is the associated MC?

MC=$5

What action should the firm take to

maximise profits?Increase output as producing an

extra unit of output with inMR>MC will add more to totalrevenue than it will add to MCand total profit will increase.


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MAXIMISING PROFITS EXAMPLE

Look at Q=4

What is the associated MR?

MR=$10

What is the associated MC?MC=$15

What action should the firmtake?

Decrease output produced untilMC=MR. As producing anextra unit of output whereMC>MR will add more to totalcost than it will add to totalrevenue and total profits will

fall. The firm can reduce thisloss by decreasing output.


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PROFIT MAXIMISING LEVEL

Profit maximising levelof output is whereQ=?

Q=3 where MR=MC


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SHUT DOWN AND BREAK EVEN

POINTS

Break Even point iswhere AR=AC. Theprice is enough tocover all costs and the

firm earns normalprofits. Point a,P=$1.30output=4000litres

Shut Down point iswhere P=AVC, P=$1.10point b


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NORMAL PROFITS

A firm will be earning

normal profit when therevenue is sufficient tocover all the costs

AR=AC.

Remember the costs ofproduction include

Rent, paid for land

Wages paid to labour

Interest paid to capital

Profit paid forenterprise

Normalprofit

AR=AC

AR

AC

MC


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SUBNORMAL PROFIT

Where the firms costs are greater than its revenue the firm is earning

subnormal profits.It is quiet possible for the firm to be earning accounting profits but because

our opportunity costs may be high it may be making an economic loss

AR

ACMC


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SUPERNORMAL PROFIT

Where the firms costs are greater than its revenue the firm is earning subnormal profits.

Only a Monopolist can sustain supernormal profits in the long run.

Perfect competitors will make normal profits in the long run, as other firms will easilyenter the market, being attracted to the supernormal profits, thus increasing supplyand resulting in normal profits

AR

AC

MC


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LONG RUN

LONG RUN: This is the time frame when all inputs become variable.

In the Long run firms may enter an industry earning supernormal profits,while those earning a subnormal profit may leave the industry.


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In the short run firms cannot enter the market and therefore individual firms already in the

market will be able to enjoy supernormal profits.In the long run, there are no barriers to entry and exit from the market. The supernormal profits

will attract other farmers to the dairy industry resulting in an increase in market supply.

Shown by increase in supply curve from S to S1

Market price will be driven downwards until all supernormal profits have disappeared., whichoccurs at the price of 1.80 where AR=AC.

Long run equilibrium for perfectly competitive market is where all firms earn normal profits.

2.00

1.80

1.60

0

S

D

S1

Q1 Qe

MR

INTERACTION OF FIRM AND MARKET IN THE


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INTERACTION OF FIRM AND MARKET IN THE

LONG AND SHORT RUN

What is the profit maximisinglevel of output and price?

MR=MC, 3 million liters, which itcan sell at the market priceof $1.60 per liter.

What is the AC at this level ofoutput?

AC= $1.85

What does this mean for theprofits earned by this firm?

Firm is only able to makesubnormal profits of

$750,000 (25c subnormalprofit x 3 million litres)

MC AC

MR=D=AR


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In the long run there are no barriers to entry or exit.

This means that in the long run some farmers will be forced to leave the dairyindustry due to the subnormal profits.This results in a decrease in market supply shown by a shift of the supply curve fromS to S1.Market price will then be driven upwards until all subnormal profits have disappearedwhich occurs at the price of $1.80 where AC=AR

In the long-run equilibrium will be where all firms earn normal profit, AR=AC=MR=MC

MC AC

MR

D

S

S12.00

1.80

1.60

0

QQ1


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IN THE LONG RUN

In the long run, a perfectly competitive firm will always be at break evenwhere

AR=AC=MR=MC

2.00

1.80

1.60

0 1000 2000 3000 4000 5000 6000

MR=D

MC

AR

Long runequilibriumof the firm

S

D

Pe

Qe

maximising profits[1].ppt

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